Ericsson CEO Börje Elholm hailed the company's first year of organic sales growth in five years as the Swedish vendor witnessed a 5G-fueled spending recovery and market-share gains in its main networks market, despite an upset at its long-suffering digital services business that weighed heavily on profits.
Full-year sales in 2018 rose 3%, to 210.8 billion Swedish kronor ($23.2 billion) -- and by 1% on a constant-currency basis -- but the organic year-on-year increase of 4% in the last three months of the year, compared with growth of just 1% in the preceding quarter, was perhaps the clearest sign that customers in some of Ericsson's biggest markets have upped spending on mobile networks after a long period of frugality. (See Ericsson Reports Rise in Q4 & Full Year Revenues.)
As customers in North America and other leading markets start to roll out next-generation 5G networks, Ekholm said that Ericsson AB (Nasdaq: ERIC) had been able to grow its share of the market for radio access network (RAN) equipment thanks to a "more competitive" set of products.
Table 1: Ericsson's Q4 Headline Figures (SEK Billions)
|Q4 2018||Q4 2017||YoY change|
|Gross margin||25.7%||21.6%||4.1 percentage points|
|Operating margin||-2.9%||-33.3%||30.4 percentage points|
|–Networks||16.5%||5.2%||11.3 percentage points|
|–Digital services||-54.5%||-103.8%||49.3 percentage points|
|–Managed services||4.1%||-18.5%||22.6 percentage points|
|Cash flow from operating activities||4.3||11.2||-62%|
|Free cash flow excluding M&A||3.0||10.2||-71%|
|Net cash at end of period||35.9||34.7||4%|
Dell'Oro, a market research company that Ericsson cites in its report, said Ericsson's share of the RAN equipment market had grown by 1.2 percentage points for the first nine months of 2018, to 29.4%, compared with the same period of 2018. Dell'Oro expects RAN sales across the entire industry to rise 2% this year.
What remains unclear is the extent to which Ericsson's growth came at the expense of Huawei Technologies Co. Ltd. and ZTE Corp. (Shenzhen: 000063; Hong Kong: 0763), Chinese rivals that have faced a growing security backlash in various international markets. Ekholm was cagey when quizzed on this topic during a call with analysts this morning.
"It has created uncertainty among customers and how will this pan out and that is not good for investments," he said. "At the same time, it is worth remembering we stand in the middle of a technology shift that creates opportunities and where it will take us we don't know. We can only invest to make sure we solve and address problems."
Some commentators have argued that Huawei's technology lead has made it hard for Ericsson to capitalize, with most Huawei customers outside a few high-profile markets standing by the Chinese supplier. (See BT's McRae: Huawei Is 'the Only True 5G Supplier Right Now'.)
Ericsson certainly appears to be a long way behind Huawei when it comes to 5G deals: It had signed ten commercial 5G contracts by the end of 2018, according to its latest earnings report, while Huawei Founder Ren Zhengfei recently claimed to have landed 30. (See Huawei Founder Fails to Put Minds at Rest.)
Nevertheless, sales at Ericsson's networks business, which accounts for about two thirds of total company revenues, were up 12% in the fourth quarter, to SEK41.6 billion ($4.6 billion), and by 6% in organic terms.
Following the publication of financial results, Ericsson's share price was trading up 2.4% in Stockholm at the time of publication.
The update comes after a tough few quarters for Ericsson during which it has laid off thousands of employees as it tries to restore profitability to historical levels. (See Have We Reached Peak Ericsson?)
While the company's networks business today looks in much healthier shape, its digital services business has continued to rack up losses. Ericsson has been exiting or renegotiating unprofitable contracts but in early January said it would give up trying to sell Revenue Manager, a business support systems (BSS) product that has apparently failed to generate any sales. (See Ericsson Will Take $860M Hit to Prop Up Digital Services.)
Ericsson took a SEK6.1 billion ($670 million) hit during the fourth quarter because of its BSS problems, writing off about SEK3 billion ($330 million) and spending the other SEK3.1 billion ($340 million) on restructuring charges. It expects to incur another SEK1.5 billion ($170 million) in restructuring charges at digital services this year.
As a result of the provisions, Ericsson fell into an operating loss of SEK1.2 billion ($130 million) during the final three months of the year, having managed a profit of SEK3.2 billion ($350 million) in the third quarter. (See Ericsson Corruption Scandal Sullies Strong Q3.)
But thanks to improvements elsewhere, Ericsson swung to a small full-year operating profit of SEK1.2 billion ($130 million), compared with a loss of SEK34.7 billion ($3.8 billion) in 2017. And if restructuring charges are excluded, the company recorded an operating margin of 9.3% -- close to Ekholm's target of 10% for the 2020 fiscal year. Ericsson's net loss, meanwhile, narrowed to SEK6.3 billion ($690 million), from SEK32.4 billion ($3.6 billion) in 2017.
Nor was it all doom and gloom at digital services: After sales at the business had fallen 6% in constant-currency terms in the third quarter, they rose 5% in the fourth and by 10% on a reported basis, to about SEK13 billion ($1.4 billion).
"In 2017 we didn't have a single product area that was profitable," said Ekholm. "The team leading and working [on this] have made real progress on turnaround and we've seen that the portfolio is competitive and we have a fairly large number of wins in the quarter."
In its report, Ericsson also indicated it has now exited, completed or renegotiated 23 of 45 contracts previously identified as problematic. It expects to have done the same for another 11 or 12 of those contracts by the end of this year.
Ekholm told analysts that Ericsson would direct investments into Ericsson Digital BSS, an older set of services with about 350 customers, following the move away from Revenue Manager. "We will fulfil customer obligations on Revenue Manager but the good thing is that we haven't had any sales so far and so we don't lose anything either -- the topline impact compared with 2018 is non-existent," he said.
Ericsson has already concluded a similar clear-out of 42 contracts at its managed services business, which swung to an operating profit of SEK1.1 billion ($120 million) in 2018, from a loss of SEK4.1 billion ($450 million) a year earlier. But sales were down by 3%, and 5% in constant-currency terms, to SEK25.8 billion ($2.8 billion).
Carl Mellander, Ericsson's chief financial officer, blamed the decline on contract exits. "Profitability improved significantly year-on-year and that is supported by cost reductions and contract reviews," he said.
— Iain Morris, International Editor, Light Reading